From the TUC

The UK’s Government Debt since WW2

13 Jun 2013, by Guest in Economics

Simon Wren-Lewis has written an interesting post on the fiscal record of the last government and Hopi Sen has written an equally interesting response. I’d recommend a look at both.

Simon criticises a recent article from the FT’s Janan Ganesh which argued that:

Of course, the fiscal crisis is mostly the result of the financial crisis. But it is worse than it should have been because of the prior failure to build surpluses, or at least run balanced budgets

To which Hopi writes:

This doesn’t seem to me to be inconsistent with Wren Lewis’s own view that it would have been better if Labour had held the debt-to-GDP ratio at the 2002 level.

I’m not so sure.

Indeed I find much of the focus of the current fiscal debate on running balanced budgets or/and surpluses to be quite misplaced.

To explain why (and this will surprise no one) I’ll use some charts. All of the data in the following three charts is straight from the IFS’s excellent ‘Fiscal facts’ series.

First, the chart below shows public sector net borrowing (PSNB) (as a % of GDP) from 1948/49 to 2011/12.

fiscal facts 1

A negative number means a surplus, a positive number means a deficit. The chart below shows the spikes in borrowing that accompanied recessions in the 200s, the 1990s, the 1980s, and the 1970s very clearly.

But perhaps what is more interesting, is the lack of surpluses. Indeed in only 18 of the 63 years below was there a budget surplus. Over the whole period the average PSNB was a deficit of 2.4% of GDP. Even excluding 1973-76, 1979-83, 1990-1993 and the period from 2008 onwards (all periods when GDP was below its previous peak) we still find an average deficit of 1.5% of GDP.

In other words, running a deficit is the norm.

Which is what makes the chart below so interesting it shows public sector net debt to GDP over the same period ()actually the National Debt to GDP until 1975).

fiscal facts 2

As can be very clearly seen, the longer term trend has been for a falling debt/GDP ratio.

Finally, below I’ve put the two charts together.

fiscal facts 3

The point I have been coming to, in an admittedly rather roundabout manner, is this: deficits are compatible with a falling debt/GDP ratio.

For example, from 1971/72 all the way until 1988/89 the UK government never ran a surplus. And yet debt/GDP over the same period fell from 60.0% to 36.6%.

To understand how this happens we need to look at debt dynamics, and the best guide here comes from an Economist blog post of 2011. In reality, getting debt/GDP down is not just about running surpluses (as demonstrated by the UK’s post-war experience) but is governed by a combination of interest rates, inflation, GDP growth and the primary budget balance (i.e. before interest rates).

The Economist piece linked to above as a handy calculator (admittedly with some data now slightly out of date). If one holds interest rates constant at 3.0% and inflation at 2.0%, then a UK which has growth of 2.5% and 1.0% primary deficit, has a lower debt/GDP ratio in 2020 than a UK which has primary balance but growth of only 1.0%. In other words there are circumstances in which GDP growth is a better way of reducing debt/GDP than running a balanced budget.

The point of this post is not rehash the arguments about fiscal policy pre-crash (again I’d recommend the two blogs linked to at the beginning of this post) but to note that when debating future fiscal rules it is important not to fetishise the idea of a surplus.  There are circumstances in which a surplus is required to reduce debt/GDP, but there are also many times when it is not.

End note: On a broader point, it would be very silly to look at the UK’s experience of reducing post-war debt/GDP from circa 220% to circa 50% from the late 1940s to the mid 1970s without considering the role of ‘financial repression’. The best single paper here is from Reinhart & Sbrancia.  As noted above both the interest rate on government debt and the level of inflation are crucial to understanding the path of the debt/GDP ratio, by ensuring interest rates are below inflation and pushing domestic financial institutions into holding government debt, government’s can reduce the debt/GDP ratio.The paper linked to above notes that:

“For the advanced economies in our sample, real interest rates were negative roughly ½ of the time during 1945-1980. For the United States and the United Kingdom our estimates of the annual liquidation of debt via negative real interest rates amounted on average from 3 to 4 percent of GDP a year.”

It is also worth noting that “financial repression” is quite a pejorative term – maybe a better one would be “successful debt management policies”.

9 Responses to The UK’s Government Debt since WW2

  1. jonathan
    Jun 13th 2013, 5:01 pm

    Think of this in confidence terms. Not confidence as in the “confidence fairy” providing a temporary spark but actual, long-lasting confidence in the future.

    If you believe in the future, you are willing to take on more debt because you believe you will have the productive capacity to pay it down over time. You take on debt because you need to develop that productive capacity – which speaks volumes about the way UK public investment has been slashed.

    Lack of confidence in the future means you need to run leaner. You can’t afford debt because you doubt you will have the ability to pay it off in the future.

    Of course you can become overly optimistic and overly pessimistic. It seems right now the UK has become so overly pessimistic that it is harming its future productive capacity in a rush to become lean enough to survive in a worse future … that the policies are now perhaps making.

  2. Bill Kruse
    Jun 13th 2013, 5:18 pm

    Quite so. Perhaps though we could avoid entirely excursions of this nature by first giving consideratin to why a sovereign nation, one which can create its own currency and through it fund its own wealth creation, should be taking on debt at all or needing a balanced budget in the first place.

  3. TickW
    Jun 13th 2013, 6:25 pm

    Excellent post!

    Here is a similar argument couched in terms of fiscal multipliers

  4. Jeremy Smith
    Jun 13th 2013, 8:15 pm

    Thanks for an interesting and important post, it is vital to keep pointing out that a ratio is just that, and is affected by relative not just absolute movements.

    My concern, and reason for this comment, is your acceptance of the term “financial repression”, though I note you did keep it in inverted commas! This is a reactionary concept, based on the premise that financial markets are being “repressed” by any act of regulation or limitation on the absolute right of finance capital to move wherever it wants whenever it wants.

    This is clear from the definition given in Box 1 of the article to which you refer. Another recent definition is in a footnote to Reinhart, Reinhart and Rogoff, Debt Overhangs: Past & Present, April 2012 where they say (apologies for length):

    “Financial repression includes directed lending to the government by captive domestic audiences (such as pension funds or domestic banks), explicit or implicit caps on interest rates, regulation of cross-border capital movements, and a tighter connection between government and banks, either explicitly through public ownership of some of the banks or through heavy “moral suasion”. It is often associated with relatively high reserve requirements (or liquidity requirements), securities transaction taxes, prohibition of gold purchases (as in the US from 1933 to 1974), or the placement of significant amounts of government debt that is nonmarketable. In principle, “macroprudential regulation” need not be the same as financial repression, but in practice, one can often be a prelude to the other.”

    Thus “financial repression”, in the authors’ minds (and recall the role that Carmen Reinhart and Ken Rogoff have played in giving intellectual support to austerity despite their “errors” and flawed logic), covers anything – reserve or liquidity requirements, regulation, capital controls, limits on interest rates, public ownership of banks… – which hinders banks and finance capital etc. from doing absolutely what they please.

    We should not accept it or use the term, as it is a concept fundamentally hostile to working people and a fair society in which finance is our servant not master.

  5. Gavin
    Jun 14th 2013, 12:54 am

    A country with a trade deficit can’t run a government budget surplus without putting the private sector in deficit (simple application of sectoral balances). We have to run a govt deficit at least equal to the trade deficit or risk putting the private sector further into debt:

    We should be fixing the trade deficit – but that means creating industries that can actually make a product that people want to buy and sell it at a price they like. And that is hard.

  6. Brian
    Jun 14th 2013, 10:12 am

    More to the point, it astonishes me that this left-wing commentator is slavishly following the neo-liberal narrative that claims public debt is bad and must be paid off – this is a lie. The ‘debt’ of a sovereign country with its own currency and a floating exchange rate NEVER has to be paid off, unlike household debt.
    The people who own 100% secure (unlike cash in the bank…) government bonds, i.e. public debt, want to KEEP those bonds, they don’t want their money back.

    The coalition debt-reduction mania is simply a smokescreen/rationale for dismantling and privatisation of the welfare state – surely you lot must know this.

    Commentator Gavin nails it – please learn something about Sectoral flows and Modern Monetary Theory.
    Start with this article from the excellent Bill Mitchell, including the linked ‘Deficit spending 101’ articles.

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